What Every Founder Needs to Know About the Valuation Gap Between Entrepreneurs and Investors

Opinions expressed by Entrepreneur contributors are their own.

With nearly 25 years on the ground both building sales organizations and generating business growth at scale, I understand the factors influencing a company’s valuation. Nine times out of ten, these metrics are driven by a genuine confidence in a product and its market potential. However, as a founder, it is crucial to fully comprehend and play into the current investor landscape to secure funding in this turbulent market successfully.

In Q3 of this year, VC investment in the U.S. dropped to $43 billion — the lowest since Q2 of 2020 due to high inflation, rising interest rates and fears of a potential recession. Now, the state of the market reveals two competing perspectives.

Amid market corrections, an overall IPO slowdown and pressure on returns, investors are more frugal than they were even a year ago and are adjusting their vision-based valuations accordingly.

At the same time, entrepreneurs are hesitant to accept funding at a level below what they’ve seen in the market over the past few years. Growing companies at all stages are posed with the challenge of raising funds at a time when it’s difficult to get their preferred valuations, and investors are extra conscious of the time it will take to see a return on their spending.

Valuation has always been a major stumbling block when negotiating with investors. Here’s what you should look out for:

Identify changing venture capital criteria

The funding environment is changing, and pretending it’s not won’t get founders anywhere. Rather than relying on old tactics, founders and CEOs can stand out to investors by realistically valuing their company and allocating resources appropriately. Looking back at past deals to vie for a higher valuation is an uphill battle that those seeking funding will not win in this market. By accepting the now and understanding the paradigm shift that is taking place in the investor/business relationship today, company leaders will have more success aligning with investors on their valuation.

Entrepreneurs will also need to lean into investors’ new criteria to prove their company’s value, whether in the early start-up stage or in the midst of seeking a later round of funding. To ensure investors are confident in their decision and will see a return, company leaders should go back to the basics — no matter the size of the business.

For example, startup founders must do their research to ensure they have a solid product that fills a real market need while remaining objective. They will need to answer hard-hitting questions from investors, such as:

Have you found a problem worth solving, and will your product do that seamlessly?
How is your product genuinely different from that of your competitors?
How will you prove this to your potential customers?
Have you interviewed potential customers and conducted experiments?
Have you fine-tuned your prices?

By the same token, more mature enterprises will need to remain nimble by leaning into what investors are looking for at later stages, asking themselves questions like:

Do I understand the investor’s portfolio?
Their investment strategy?
Have they successfully invested in a company within the same vertical?
Do I have hard success metrics I can point to?

It’s time for companies to drop the “I have a unicorn” mentality, which means actively challenging their own assumptions about a product’s market potential. Unicorns are rare, and it’s time to acknowledge that — overvaluing a company will deter investor trust.

In this market, investors have the power and may opt for referential treatment from businesses in exchange for investment. This can include liquidation preferences, preferred shares, allocation of board seats and more. In conjunction with approaching investors with realistic expectations, leaders should be prepared and open-minded to these negotiations, as it could help secure a higher valuation.

Leverage leadership

When trying to secure funding, team credibility is huge in gaining attention and trust from investors, especially in a turbulent market. Companies must build a team of reliable leaders with dedicated roles in their business — those with a proven track record of creating efficiencies and executing go-to-market (GTM) plans.

A company or product backed by leaders who have built successful businesses and understand how to fine-tune a GTM plan goes a long way toward rallying enthusiasm and interest. Successful executives know how to get an idea off the ground and have the network to help it reach fruition — and investors take note. In addition, having a well-connected team also helps to rally general interest from the entrepreneurial community and potential customers.

It is easy for founders and CEOs to narrow their focus on current funding efforts. However, it is also paramount to look ahead by nourishing existing connections. Leaders should surround themselves with hard-working visionaries with similar business interests and values to open the door for a later-stage partnership or collaboration in a future venture.

Approach with hard data

Under the current market conditions, attracting funding requires more than simply having an intriguing product and a big idea. Today, companies must be prepared to show hard data and how that will translate into their GTM strategy– saying no to theoretical numbers and showcasing proof of concept and scalability through data is critical.

With strong data to help support their vision, founders and all business leaders can easily field questions like: How is your company truly performing? How will you continue to drive revenue six months down the line?

Identifying the ROI a company can offer an investor will be vital in securing a preferred valuation and investment.

Adjust in real-time

A solid GTM plan is crucial in securing a desired valuation and maintaining investor interest. To do this, companies must establish a “single source of truth.” When metrics are pulled from multiple sources with different processes and standards, investors will see holes in the plan, which will show a lack of consistency and be deemed non-credible to investors – an observation that is very difficult to bounce back from.

Traditionally, GTM and operating plans are siloed based on misaligned priorities, insufficient data and subjective perspectives. Not only does this cost businesses time and energy, but misaligned business functions and unorganized budget allocation is bad news for investors. Companies that can present metrics from a single source will see greater operational transparency, a more unified planning experience, and more calculated growth. A consistent reporting format like this will allow teams and investors to know where they stand concerning sales goals and how to adjust strategies to optimize success.

To achieve a more unified planning process, business leaders can leverage data-informed AI platforms, which use ML insights to identify patterns and discrepancies that can maximize success. In this context, AI can provide insights that empower organizations of any size to look to the future to see which decisions will have the biggest impact on the bottom line, which mitigates risk. Additionally, these models enable companies to gather data and continuously re-evaluate the allocation of funds.

It all comes down to trust

Understanding what investors want to know and providing transparent access to those metrics in the current market will make or break these partnerships. Researching current investor criteria is crucial in being prepared for what investors are looking for in a funding pitch while leveraging leadership will increase confidence in their projections. Investors will need to trust where entrepreneurs are getting their data and their ability to adjust GTM plans in real-time to cater to ever-changing priorities.